When informal workouts don’t work out: English High Court rules bank that lent support to restructuring did not dishonestly assist in putting assets beyond creditors’ reach
By Gareth Thomas, Jojo Fan, Peter Ng, and Grace Lee (Herbert Smith Freehills)
In the current economic climate, more and more companies are getting into financial difficulties, informal workouts by debtor companies, with support from certain creditors, seem to be increasingly common. The latest English High Court decision of Henderson & Jones Ltd v Ross & Ors [2023] EWHC 1276 (Ch) highlights a possible litigation risk for the supportive creditors – banks or funds alike – and the advisors involved, especially if the informal workout ultimately falls through.
From time to time, financial institutions are sued by liquidators of wound-up companies for dishonest assistance based on their past dealings with the company. We have defended a few of these claims, ranging from the more commonplace (e.g. the bank acted as a sponsor in the listing of the company now in liquidation), to the novel (e.g. the bank offered trade financing to the company in question).
In yet another novel scenario here, English High Court rejected an allegation of dishonest assistance against a bank. The claimants were litigation funders who took assignment of the claim from a company now in liquidation. The company had pursued a restructuring. The claimant alleged that the restructuring of the company was a scheme to defraud its creditors by putting its assets beyond reach of creditors, and sued various parties involved in the restructuring, including the company’s directors and the company’s bank.
Background
In this case, the bank was the company’s banker. The bank entered into various loan facilities and overdraft facilities with different entities within the company’s group, which were secured by a number of guarantees, charges and debenture agreements since August 2009. Over the course of the company’s restructuring efforts, the bank maintained its relationship with the company, provided refinancing of loans, and consent to several asset transfers and debt conversions within the group as part of the restructuring. The claimants alleged that the bank knew, had a targeted suspicion of, or turned a blind eye to the restructuring’s effect to defraud on creditors. Thus, the claimant alleged that the bank dishonestly assisted in the fraud.
Decision
The Court held that the company’s directors had not breached their duties to the company, and so no question of accessory liability in dishonest assistance on the part of the bank arose. However, the Court also found that the bank had not acted dishonestly in any event.
In a lengthy judgment, the English High Court reconfirmed that the “dishonesty” element of the dishonest assistance claim required the Court to first ascertain the actual, subjective state of the person’s knowledge or belief as to the facts, and only after that has been established will the court determine (objectively) whether the conduct of the person was dishonest by applying the standards of ordinary decent people.
Relatedly, for “blind eye” knowledge to be imputed to a person, the Court reiterated that it must first be shown subjectively that the person suspected that certain specific facts may exist and, second, that the person then made a conscious decision to refrain from taking any steps to verify the existence of those facts.
In that regard, the English High Court closely scrutinised whether the liquidators demonstrated sufficient and credible motive on the bank’s part, and the overall probability of such dishonest conduct. In particular, the Court found the senior bank employee alleged to have the dishonest knowledge or suspicion forming the basis of the bank’s liability was in fact an “impressive witness” and an “honest banker (and witness)” with experience spanning decades. The Court further commented that although his “innate honesty might not preclude a lapse, this seems inherently improbable”. Furthermore, the Court was able to rely heavily on the senior employee’s meeting notes/emails and specific legal advice taken by the bank in deciding to reject the dishonest claim against the bank.
Comments
In Hong Kong, we have not yet seen any dishonest assistance claims mounted against supportive creditors in an abortive restructuring, but it is certainly something to bear in mind.
The following observations are also of interest to our Hong Kong readers:
(1) This case bears remarkable resemblance to a Hong Kong case, Re Galleria (Hong Kong) Limited [2019] HKCFI 1877, in which we successfully defended a bank after a 15-day trial and on appeal (see our blogpost about the Court of First Instance and Court of Appeal decisions here and here). In that case, as in this case, the liquidators relied heavily on a few particular emails to allege dishonesty on the part of the bank. In Re Galleria, the Hong Kong Court also took a holistic view of the evidence given by the bank’s officers and read the contemporaneous documents with “sound common sense”. The Court found that contemporaneous documents showed that the bank’s officers did not have any knowledge or serious suspicion of fraud. Accordingly, the Court considered that it defied common sense for the bank’s officers to knowingly ignore a fraud against the bank and continue to approve lending to the fraudster, and that there was no motive for them to do so.
(2) The test for dishonesty applied by the English High Court mentioned above is consistent with the test applied by the Hong Kong Court in Re Galleria. In both cases, the Courts cited the English Court of Appeal decision in Group Seven Ltd v Notable Services LLP [2019] EWCA Civ 614 when considering how blind-eye knowledge can be imputed. The Group Seven test is discussed in detail in our earlier blog post here.
(3) In this case and Re Galleria, the lack of a credible motive for dishonesty and the “inherent probabilities as a matter of common sense” were key factors in favour of the defendant bank.
(4) Furthermore, the English High Court placed a lot of weight on the fact that the bank made enquiries about the restructuring plans, and sought appropriate legal advice and that these were contemporaneously documented. This is again similar to what the bank in Re Galleria successfully demonstrated to the Hong Kong Court. These Court decisions demonstrate the importance for financial institutions to keep contemporaneous documentary records of transactions and comprehensive document trails to address future enquiries or defeat claims brought by its former clients (including through their liquidators). This also helps a Court to take a holistic view of the events, as mentioned in point (1) above.
(5) The English High Court commented that when dealing with a corporate group, it was reasonable for a bank to consider matters holistically at the group level rather than in respect of individual companies within a group. We would note that the position would be different for the directors concerned, who might be holding multiple offices within a group. As directors, they will need to consider the interest of creditors of each company in a group separately as to whether the creditor duty arises in respect of that company.
(6) This claim was brought by a litigation funder who took assignment of the claim from the company in liquidation. In Hong Kong, insolvency litigation is one of the major exceptions to the general prohibition against litigation funding. See our earlier blog post here.
For more details, please see our blog post on the English High Court’s latest judgment here.
* This article was originally published by Herbert Smith Freehills LLP.